Wednesday, July 16, 2014

... China's economy is clearly not out of the woods, concerns are mounting... China's property bubble may have already burst and the economy could slow dramatically... Oversupply in the real estate markets, high leverage, and inadequate bank reserves have triggered many economic calamities across the globe... Looking back at the sovereign credit crisis, in Ireland, Spain, Portugal and US, it is clear that the property markets are not likely headed for a soft landing...

The gross domestic product in the world's second-largest economy expanded by 7.5% in the second quarter. While economic growth has returned, albeit barely, China's economy is clearly not out of the woods, concerns are mounting about high leverage, reduced bank reserves and a quickly cooing real estate market. History suggests that a housing shock could ripple through the broader economy, especially the banking sector, which provides financing to developers.

The gross domestic product in the world's second-largest economy expanded by 7.5% in the second quarter, compared to the same period last year, according to the National Bureau of Statistics. After years of robust expansion, China's economic growth rate has slowed in recent quarters, in part due to a decline in demand for its exports from key markets. Indeed, this is the first time the economy has accelerated in three quarters, and puts China on somewhat better footing to reach its official growth target of 7.5% for 2014, but the headline should not stop here.

To revitalization China's slumping economic growth, which reached an 18-month low of 7.4% in the first quarter of 2014, the government said it would cut taxes on small firms and speed up the construction of railway lines across the country. Further, last month, China's central bank said it would cut the amount of cash banks needs to keep in reserve for banks engaged in lending to agriculture-related businesses and small companies, to make more cash available for lending.

"While economic growth has returned, albeit barely, China’s economy is clearly not out of the woods, concerns are mounting" Steve Picarillo said. "Indeed, debt outstanding is massive, as historically the economy was fueled by credit, and reducing reserves at banks introduces trepidation as to the ability to absorb losses from the overheated property markets. Leverage and doubt is not a good combination."

"Additionally, and likely more importantly, oversupply in the real estate markets is a significant concern in China," Picarillo continued. Property construction has been growing at an unsustainable rate, however demand has diminished, leaving developers with an increasing level of inventory of unsold property. This leaves the potential of a gaping hole in the economy as the real estate sector and related services is estimated to be about 20% of GDP, and property investment alone accounted for more than 15% of economic growth last year.

The real estate/property sector has the size and scale to be a real drag on the economy. "However, the drag can be more than a mere nuisance should the market weaken further and the economy fail to gain momentum in the other sectors, such as exports and manufacturing," Picarillo added.

Historically, an overheated real estate market, overbuilding, high leverage and inadequate bank reserves have triggered many economic calamities across the globe, Ireland comes to mind. History suggests that a housing shock could ripple out to the broader economy, especially the banking sector, which provides financing to developers. In addition, real estate is closely tied to the manufacturing and services sectors. "All we need to do is to look back at the sovereign credit crisis, in Ireland, Spain, Portugal and even to US, to see that the property markets are not likely headed for a soft landing," Steve Picarillo added.

"China’s property bubble may have already burst, and the country's economy could slow dramatically unless the additional stimulus measures are enacted." Picarillo concluded, "However, it may be too late, the horses are out of the stable." Steve Picarillo is a global financial markets, risk and communications executive with exceptional experience in risk analysis of global banking systems and financial institutions. Mr. Picarillo provides analysis and commentary to the financial community, the media, investors and regulators.

The opinions in this article are the views/opinions of the author and Creative Advisory Group, Inc. (CAG), based on public information and the author’s experience. This is not a recommendation to buy, sell or trade any security, debt or any other financial instrument. The author and CAG do not hold any interest in any of entities mentioned in this posting, and have no plans of entering into any financial trade in the same in the next 72 hours.